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After a buoyant and positive January, most market participants seemed to be sure that the trend for the whole of 2023 was set. Benchmark yields almost reached their peaks, so an upcoming reduction in interest rates (given expectations of a mild recession and cooling inflation) makes investments in certain market segments appropriate. However, February has dealt unpleasant hands for many. Inflation data showed an unexpected increase, consumer demand turned out to be stronger than expected, and indices of economic activity continued to balance at levels indicating, albeit weak, but economic growth.
Bond markets suffer
Given such an informational background, government bond yields in both the US and Europe added, on average, 50 basis points across almost the entire yield curve. The forecast for the terminal rate (the peak value of the Fed rate in the current cycle) increased from 4.75-5.00% to 5.50%, the deadline for reaching these levels shifted from June to October, and the minimum rate for the next cycle of rate reduction increased from 3% to 4%. We were mentioning the risk of yet another yield rally before market decides to turn. We believe that yields will see a local top closer to summer when we will consider shifting to longer maturities.
European and US equity markets
No one is expecting a recession?
Has the market decided that recession can be avoided? Both dollar and euro yield curves signal the opposite, with yield curve inversion (a condition where longer-term bond yields are lower than short-term yields) being at record levels. In the US, similar situation was observed in the late 1970s, when the Federal Reserve also struggled with rising inflation (the 17-year long period of the Great Inflation of 1965-1982). Then the Fed was accused of being slow and indecisive, what at some moment triggered a dramatic increase in rates. Today, the rhetoric of central bankers sounds more determined – they have repeatedly stated that it is too early to pause or press the brake pedal in this cycle of rising interest rates, as one needs to make sure that the fight against inflation is successful. We must see unemployment rise, spending decrease and, finally, inflation decelerate. It should be assumed that market’s sensitivity to the economic data would only increase.
Benchmark 10-year bond yields
Company reports show weakness
The reporting season is now over. Sales and revenue growth is at multi-year lows. 26.1% of the S&P 500 companies showed a decrease in revenue and 36.6% decrease in income. Average revenue growth was 5.6%, while revenues decreased by 2.9%.
Companies in the real estate, energy and industrial sectors, as well as manufacturers of consumer goods, reported above-average results. At the same time, the consumer goods sector (thanks to Tesla shares, which rose by 18% in February) and the industrial sector managed to outperform the S&P 500 in February, while the real estate and energy sectors were in the top-3 of worst performers.
Dollar and precious metals do not surprise
As many suspected, EUR/USD tested a 1.1000 mark and was rejected from that level rather decisively. Nothing changes in the larger picture with 1.1000-1.1300 zone being a major long-term resistance. In the upcoming weeks, we see 1.0800 and 1.0450 levels as resistance and support for the pair, with everything below EUR/USD 1.1300 making us euro bears.
Precious metals did not have the best of months; however, we still consider this slide in silver as a “healthy” and somewhat expected correction, which allows adding to long positions. In silver, major level to watch now is 25 dollars per troy ounce, while XAU/USD is locked in the large horizontal trading channel between 2000 and 1700 with market considering these boundaries as «expensive» and «cheap» respectively.
High Yield bond Indexes
Chinese economy makes a return
US manufacturing contracted for the fourth month in a row, though new orders showed an improvement that could signal at least some stabilization in factory activity. Consumer confidence contracted during the month, Conference Board’s survey showing consumer anxiety among lower-middle-income households especially (the index decreased by three points to 102.9 in February). Meanwhile US labor market stayed strong – initial jobless claims decreased despite all forecasts.
Manufacturing sector contracted in the Eurozone as well, although supply chains continued to show improvements as input price index fell to 50.9 in February from 56.3 in January (the lowest reading since September 2020). Inflation data for the block came in with core rate rising again – to 5.6% in February from 5.3% a month ago, which will reinforce the case for the European Central Bank to keep raising interest rates. The Eurozone’s largest economy, Germany, also posted shrinking manufacturing activity, while inflation readings there came in higher than anticipated.
Things were better in the Middle Kingdom with Chinese economy working fulltime in February. Manufacturing showed a rapid growth and services sector expanded at the fastest pace in six months supported by customer demand. Caixin/S&P composite PMI increased to 54.2 compared to 51.1 in January, marking the fastest expansion since June 2021.
Gold price, USD/oz
Too early to get into a fight
What to do in this situation? In the S&P 500, 3780-3880 is the critical support zone and, if broken, will open the way to 3450 levels and further to 2700. If the market manages to hold current levels, then we are more likely to see a retest of recent highs at 4150, and possibly reach 4300-4550 zone. In our opinion, purchases at current levels are impractical – it is much safer to step aside and watch bulls and bears fight it out.